Prudential’s Srinivas Reddy, senior vice president for full
service investments, and John Kalamarides, senior vice president for institutional
investment services, penned the white paper, “Guaranteed Lifetime Income and
the Importance of Plan Design,” which was shared with PLANADVISER prior to publication.

The research suggests plan design—most notably the makeup of
a plan’s qualified default investment alternative (QDIA), along with the
adoption of automatic enrollment and deferral escalation—play a pivotal role in
unlocking the full potential of lifetime income solutions. Reddy and
Kalamarides suggest the time is right to build a smarter QDIA that begins the
process of building a lifetime income stream from the first day of
participation in the retirement plan.

To test this premise, the white paper looks at real
participant outcomes based on plans’ decisions to utilize a QDIA that includes
a guaranteed lifetime income portion. The study tracked more than 1,900 defined
contribution plans served by Prudential and more than 2 million participants
between December 2008 and December 2013, Reddy tells PLANADVISER. It centered
on the impact that Prudential IncomeFlex has had on participant behaviors and
outcomes.

As explained by the white paper, IncomeFlex is a guaranteed
lifetime retirement income benefit that can be combined with a wide range of
underlying investment programs, including target-date funds, interactive asset
allocation programs, custom balanced portfolios and managed accounts. While
Prudential had already been offering the product for use in QDIAs, the solution
received an additional nod of approval from regulators in late October when The
Department of the Treasury and the Internal Revenue Service issued guidance
designed to expand
the use of income annuities in 401(k) plans.

“In short, our research found that starting participants
with a lifetime income investment supports and improves the benefits generated
by automatic enrollment, automatic contribution escalation and other prominent
plan design features,” Reddy says.

Notably, the paper shows plans in Prudential’s book of
business with automatic enrollment and a default investment option that
includes IncomeFlex have an average participation rate (87%) that is
substantially higher than plans without IncomeFlex or automatic enrollment
provisions (65%). Plans with only IncomeFlex but lacking auto-enrollment do
somewhat better, at 72% participation, Reddy notes.

“When
workers are left to their own devices in a plan without a guaranteed income
benefit, participation rate is a relatively disappointing 65%,” Reddy explains.
“While adding IncomeFlex to a plan’s investment lineup improves that
participation outcome, the highest rate is achieved by combining IncomeFlex
within a default investment that is coupled to automatic enrollment.”

While some in the marketplace have concerns that adding
in-plan guaranteed income (which typically involves tying up account dollars
for long periods of time) could increase opt-out rates, Reddy says the
Prudential paper actually shows the reverse is true—as plans with IncomeFlex
show a nearly 3% reduction in opt-outs over those without in-plan income.

The white paper also examines the impact lifetime income
offerings have on “non-automatic enrollment participants,” or those who were
not defaulted into a plan’s QDIA. As with defaulted investors, Reddy says there
appears to be a positive impact on plan-related decisionmaking when lifetime
income is made available.

“For example, plans without IncomeFlex or automatic
enrollment had 7.8% average salary deferrals, while those with IncomeFlex had
8.3% average deferrals,” Reddy explains.

When combined with automatic contribution escalation, the
impact is even greater, Reddy adds. Between 2010 and 2013, participants in
plans with IncomeFlex but without auto-escalation saw their average
contribution rate grow from 4.6% to 6.7%, for 46% growth. At the same time,
participants in plans with auto-escalation and a QDIA with IncomeFlex saw their
average contribution rate grow from 4.4% to 7.0%, for a 59% growth.

“These findings are good news for plan sponsors and
participants in light of the fact that nearly half of DC plan sponsors have
noted ‘increasing participants’ savings rates’ as the number one or two
priority on their list,” Reddy says.

The paper concludes by showing intelligent plan design that
leverages diversified QDIAs, in-plan lifetime income, and automatic enrollment
features can reduce the number of undiversified investors (those with 100% of
assets in either stocks or bonds, or heavy concentrations in single securities)
by as much as 67%.

Reddy and Kalamarides close the paper with three tips:

Start
participants saving and investing as soon as possible for the purpose of
generating future retirement income;

Start
them off with an investment option that delivers appropriate
diversification and offers “guardrails” against behaviors that can push
them off track; and

Provide
a mechanism to increase participants’ base for guaranteed retirement
income as their earnings grow.

“In our opinion, this is the definitive formula for
transforming America’s retirement industry for the betterment of all, taking
American workers from their day one of employment to their day one of
retirement with confidence,” the pair writes.